Is the rise of Islamic finance good news for the environment?

Economic and ethical focus of fast expanding Islamic banks could be good news for green investments

By Nilima Choudhury

The growing Islamic finance sector could spell good news for investments in clean energy according to experts RTCC has spoken to.

Islamic finance is growing 50% faster than the traditional banking sector, and it has huge growth potential, with assets expected to increase by 250% this year.

Its profile was boosted last week when UK Prime Minister David Cameron told the World Islamic Economic Forum he wanted the country to be the “first western sovereign to issue an Islamic bond”.

Is the rise of Islamic finance good news for the environment?

In an interview with RTCC, Professor Habib Ahmed, a World Bank author and Professor in Islamic law and finance at the University of Durham said the principles and values on which Islamic finance is based could contribute to sustainable economic development.

“There is an increasing demand from different stakeholders that Islamic finance should also reflect the ethical, social and environmental aspects in their financing,” he said.

“Many non-Muslims are attracted to Islamic finance because they find it sound from economic and ethical perspectives.”

This could be positive news for the clean energy sector that in 2012 suffered a 14% drop in investment as Europe curbed green subsidies and the USA’s attention was diverted from renewables to fracking.

Last month analysts at Bloomberg New Energy Finance reported that annual investment in renewables and energy-smart technologies will fall for the second consecutive year.

Emerging sector

There are already signs the clean-tech sector is starting to benefit from Islamic finance.

The Islamic Development Bank (IsDB) is already a major player in the clean energy sector investments of around $1 billion between 2010-2012.

Last month the IsDB agreed a $100 million investment with the Industrial Development Bank of Turkey for the development of renewable energy and energy efficiency projects.

On a wider scale, a report by Ernst & Young published in December 2012 valued Islamic assets at about $1.8 trillion in 2011, representing about 1% of the global financial market.

Green shoots

Some analysts believe Islamic finance will be good for the environment because it values more than just profits.

Western banks are required by law to provide the best return on investment for their clients regardless of where that investment goes.

But according to Asad Zaman from the International Institute of Islamic Economics in Pakistan, while green growth in the west is secondary to economic growth, this is not the case in Islamic financial circles.

“Natural resources are a sacred trust and protecting them for future generations a primary responsibility,” he said.

“Economic growth is not (directly) a goal at all, though it may be desirable as a means to (say) poverty alleviation.”

It’s a view shared by the heir to the British throne Prince Charles, who recently said Islamic banking could provide the answers where conventional banking could not, given Islam’s emphasis on a “moral economy”.

Where large Western banks have divested from oil and gas, it has generally taken place not because of ‘green’ reasons, but as a result of long term investment planning.

“Scottish Widows divested from these [fossil fuel] companies not on ethical grounds but because we think they’re not a very good investment decision. That view is shared very widely in the investment community,” said the bank’s head of sustainability Craig Mackenzie.

New investment model

The Islamic financial structure is so attractive that the UK Treasury is now investing about £200 million to work on the practicalities of issuing “sukuk”, or Islamic law compliant bonds in the country.

Sukuk bonds do not pay interest, but instead offers the investor a share of ownership in the project they are supporting.

In order to develop an environmentally friendly sector financed by Islamic banks, the Green Sukuk Working Group was launched last year by think tanks Climate Bonds Initiative, NGO Clean Energy Business Council of the Middle East and North Africa and the Gulf Bond & Sukuk Association.

“Interest in both Shari’ah compliant and ethical investing is on the rise. Green sukuks can support this trend by expanding the range of available financial instruments,” said the GBSA’s Michael Grifferty at the group’s launch.

“Green sukuks also support national development strategies by offering longer term finance for essential infrastructure.”

The group aims to develop best practices and promote the issuance of sukuks for the financing of climate change investments and projects, such as renewable energy projects.

Banks like UK-based Islamic investment bank Gatehouse Bank offer people the opportunity to invest in sustainable companies that offer technology, products and services throughout the water industry to help with water desalination, a burgeoning sector in the Middle East.

According to Professor Ahmed, the Islamic financial sector’s growth is likely to continue because it has proven to withstand events like the 2008 global financial crisis.

“After the crisis, Islamic finance came to light because it had features that would have lessened the intensity of the crisis,” he said.

Social responsibility

A paper published in July this year by the International Institute for Sustainable Development (IISD) argues that increasing levels of debt in the ‘West’ will make Islamic banking a safer bet for many investors.

“Islamic finance principles serve to insulate the Islamic financial system from excessive leverage, speculation and uncertainty, which in turn contributes toward promoting financial stability and long-term sustainability,” the authors say.

“As a result, the implementation of Islamic finance principles is anticipated to grow, not only in Muslim countries’ financial markets, but also in those markets concerned with socially responsible objectives and ethical financial solutions.”

Muhammad bin Ibrahim, the Central Bank of Malaysia’s deputy governor, argued earlier this month that it was an Islamic bank’s duty to “enhance the general welfare of society.”

“The teachings of Islam basically promote preservation of natural resources and the need to respect all living things. Failure to do so would be detrimental…where severe destruction of the land and sea would come upon those who mistreat the environment,” said Ibrahim.

There are, of course, plenty of examples of Islamic banks lending to oil and gas companies. Money based in Saudi Arabia and Qatar is, in all likelihood, derived from the extraction of fossil fuels.

But the rapid growth of a financial sector underpinned with strong ethical and environmental leanings indicates that the damage investments may do to the planet may come under increasing scrutiny.

Ahmed argues that currently there is little sign of a “green” culture in the Islamic financial sector, perhaps not a surprise given its relatively small size.

But he says there is a debate among bankers over what the sector’s role should be moving forward, and how it can be a force for the global good.

“As the industry moves forward it will be expected that they consider social and environmental issues as the values on which Islamic finance is based on [these] demands,” he said.

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